Last year, a case in California discussed when an insurance company has an obligation to defend HOA board members and, more specifically, HOA Board members appointed by the project developer. It is quite common for developers, when building projects involving the formation to a homeowners association, to create the association and then appoint an initial board made up entirely of employees of the developer.
A Breach of Duties
These appointed board members make decisions on behalf of the HOA, but with an obvious eye toward the developer’s interests. In this case, three developer-appointed HOA board members were sued for actions they took on behalf of the HOA in their capacity as board members. They were accused of breaching their duties to the HOA by making decisions for the HOA that benefitted the developer and hurt the HOA. The HOA’s D&O carrier refused to defend them, pointing to an outside interest exclusion. The appellate court agreed with the insurer—a result that should serve as a warning to any developer that appoints its employees to an HOA board (and perhaps even more so to the developer employees so appointed).
A developer obtained land and decided to build several new homes as part of the development. The company, JTS Communities, Inc., built a total of 222 homes in the development, and left four hundred acres untouched as part of a communal area that residents could use for various activities. The homeowners believed that the developer would convey the property to the governing HOA, to ensure that it remained available for use later.
However, JTS notified the HOA and its board members that it planned to sell the communal area property to a third party, which led to litigation. The homeowners and the HOA brought suit against JTS, wanting to prevent such a sale from happening.
In this case, three board members of the HOA had ties to JTS. Later complaints in the suit added claims against these three individuals as well, which is where the insurance issues come into play. The three board members believed the HOA’s D&O (directors & officers) policy required the company to defend them in this litigation, as they were being sued in their capacity as HOA directors/board members.
Understanding the Insightful Court Conclusion
The court concluded that the insurance company did not have a duty to defend the board members. It relied on the outside capacity exclusion, which barred coverage for claims “arising from the insured serving in any capacity in any organization which at the time of such service is not an insured under this policy.”. The court’s rationale was that the individuals were acting, at least in part, in their capacity as JTS employees and owners. Since JTS was not an insured party under the policy, the majority felt that these allegations were enough to trigger the outside capacity exclusion.
The dissenting opinion, however, made for some insightful observations as to the problems that the majority’s opinion creates for developers and, especially, developer-appointed HOA board members. Initially, the dissent points out that developer-appointed members of the board were made known to the insurer. Indeed, board members were specifically identified as being JTS—affiliated. Further, the dissent also recognized, as the developer-appointed members emphasized, that “…a developer’s role in the management of a homeowners association is anticipated, known, and regulated. If [the insurer] intended to exclude developer-directors from coverage during a period where several, if not a majority, of the board’s directors were developer-directors, it had an obligation to do so in a plan, conspicuous, and clear manner.”
Finally, the dissent noted that outside services exclusions are intended to prevent the policy apply to situations where an insured director or officer is sued for a wrongful act, but that wrongful act is committed in a capacity other than as a director or officer of the insured corporation.
Howsoever one views the result reached by the majority in this case, it serves to emphasize the importance of carefully placing D&O coverage for a new HOA or any HOA that still has developer-appointed members serving on the Board. Take the time to review your policies, and make sure you understand your rights and obligations for your circumstances. Please reach out to our team if you or your organization need help in this process.